How Can Short-Term Business Loans Help Business Owners?
Every business needs a constant flow of money or liquidity to keep the operations going. At times that money can be found in the form of revenue; however, due to delays or any unforeseen circumstances or other contingencies, that amount has to be borrowed. Borrowings for the purpose of business expenditures are called business loans.
Business loans are of two types. These are short-term and long term loans. You can choose to avail any of the two based on your necessities. Suppose you need immediate finance for small-scale expenditure, or for a seasonal purchase of inventory, in that case, short-term loans can be perfect.
What Is a Short-Term Business Loan?
A business loan taken for a tenure of less than a year is called a short-term business loan. The tenure of the loan may vary from three months to a year. These loans are also called working capital loans as it provides emergency capital for short-term financial problems.
Since these loans don’t require collateral, it’s good for start-ups or small businesses that don’t have an asset to pledge. However, if the loan gets defaulted, it will affect the credit score of the borrower which can prevent the borrower from availing further short-term or long term loans.
What Are the Eligibility Criteria to Apply for a Short-Term Business Loan?
To apply for a short-term business loan, both the borrower and his business need to fulfil certain criteria. These are:
- The borrower must be above the age of 18 or 21 years (depends on the lender) while applying for a business loan. The borrower’s age shall not exceed the age of 65 years when the loan matures.
- The borrower should be a resident of India.
- The borrower must have a minimum monthly income as prescribed by the lender.
- The borrower should have a bank account.
- Lots of lenders require the business to have a Minimal Annual Income (ITR) of ₹1.5 lakh per annum.
- Many lenders require records to show that the business has been profitable for the last 2 years.
- The business should have a trading or manufacturing licence.
- Some lenders may ask for the last few months’ financial history.
These criteria are not uniform and vary across lenders.
What Are the Different Types of Short-Term Business Loans?
The different types of short-term business loans have been described below:
- Trade Credit
A consumer is permitted to buy products or services on trade credit, a sort of business financing, and pay the lender at a later time. Businesses can finance short-term expansion and free up cash flow by using trade credit.
- Line of Credit
A flexible loan from a bank or other financial institution is known as a line of credit. A line of credit is a sum of money that can be accessed as needed. It works similar to a credit card loan but has a fixed credit which gets replenished each time you make an EMI payment.
The rate of interest is calculated on the amount borrowed and not on the entire loan amount.
- Invoice Financing
Receivables financing, often known as invoice financing, enables small firms to swiftly obtain capital for unpaid business-to-business invoices. A business pays the invoice finance provider a charge, usually a percentage of the amount borrowed, in exchange for quick access to cash. These invoices act as collateral for the lender.
- Business Credit Cards
Unlike personal credit cards, which are used by individuals, business credit cards are made for usage by businesses. Having a business credit card can be a useful method for small business owners to keep their business and personal costs apart for bookkeeping and tax purposes. The rate of interest is high for this type of loan as it is unsecured.
Advantages and Disadvantages of Short-term Business Loans
The pros and cons of availing short-term loans are discussed below.
- Short-term business loans can be easily applied for and they usually get approved within 48 hours.
- Short-term loans can be customised according to the ease of payment of the borrower. EMI amount, time period and rate of interest can be adjusted to the borrower’s ability to repay.
- Interest paid on short-term loans is tax deductible.
- No collateral is needed to apply for this kind of loan.
- Since these loans are unsecured in nature, they have a higher rate of interest, compared to longer-term loans.
- Early repayment of loan may attract early repayment fees.
- Borrowers may tend towards being dependent on borrowing and apply for multiple short term loans in succession.
Short-term loans can ease the flow of cash for businesses during a financial emergency. But you should be entirely sure of the amount you want to borrow and choose between short-term loans and long term loans accordingly. This way, you won’t have yourself running into two short-term loans simultaneously.
Frequently Asked Questions
Do banks offer long term business loans?
Some banks and financial lenders offer long term loans to businesses that have a good credit history. The repayment tenure of such loans tends to be 3-5 years; the rate of interest is lower than short term business loans.
Are short-term loans risky?
Short-term loans generally have higher EMI amounts to be paid as the borrowed amount needs to be paid over a shorter period of time. These loans are riskier than long term loans as there is no collateral involved so banks also charge a higher rate of interest.
Are short term loans easily available?
As the lent amount is relatively small and requires minimal documentation, they are readily available. These types of loans are also given to people or organisations with low credit scores and the rate of interest charged is higher.
What is the minimum credit score required to apply for a short-term business loan?
A minimum CIBIL score of 650 and above is considered to be a good one. So borrowers with CIBIL scores above this level usually don’t have any problem getting approval from the lender for a short-term loan.